Two proponents of best execution for trading argue the reason why trading volumes in Asia remain relatively low is due to a lack of competition.
In 2007, Asian stock exchanges including Japan and Australia experienced a combined $20 trillion in trading volume. That seems like an awful lot. But it's a fraction of the volumes experienced in the United States and Europe. "We haven't seen the explosive growth in volumes in Asia, because of a lack of competition," asserts Tony Mackay, chairman of Chi-X Global in Hong Kong.
He spoke last week at a Fix Protocol conference in Hong Kong.
In the US, exchanges by law must route orders to the venue with the best price. Brokers are required to pursue best execution. Although the American market has seen the proliferation of dozens of alternative trading venues and dark pools, the market is still dominated by four players: NYSE, Nasdaq, electronic venue Bats and, just in the past six months, another alternative electronic exchange, Edge ECN.
In Europe, the London Stock Exchange is dominant, but there is plenty of competition, and Chi-X now ranks as the fourth largest exchange in Europe in terms of turnover, Mackay says. He says if brokers in Europe had to adhere to a fiduciary responsibility to seek best execution, the exchanges would fall behind. Even now, alternative trade facilities account for 30% of trading volume against the FTSE100, because they offer lower operation costs and superior technology, which translates into narrower bid/offer spreads.
Can this sort of competition be introduced to Asia? Mark Wheatley, managing director and head of electronic trading at Merrill Lynch, says there is no regulatory initiative across the region that resembles US law or Europe's Mifid, which forced competition among its national exchanges and clearing houses.
He also doubts the market will force much change on its own: in Europe, the buy-side never initiated these changes, even though it's the buy-side that primarily benefited. Mifid obliged sell-side brokers and banks to pursue best execution, but it placed the onus on the buy-side to understand banks' various best-execution policies and technologies.
Wheatley argues that the scarcity of liquidity across Asian markets, rather than regulation, could drive change. Fund houses are generally less concerned about market impact than with getting a trade done. But the European and US examples show that best execution adds to liquidity, which means this is a topic that will remain prominent among Asian market participants, Wheatley says.
Among the biggest obstacles in Asia is the lack of a consolidated tape showing prices across markets for a bid or offer. In the US, lit venues (as opposed to dark pools) place all their prices on the same data feed, and exchanges route trades to where the price is most competitive. In Europe, this hasn't happened, because the exchanges block any attempt to introduce a consolidated tape. In Asia, there's no equivalent to Mifid, so the notion of visible pricing across venues is a long way off.
However, if dark pools become significant players (which they are definitely not right now, in terms of trading volume; they are less than 1% of total exchange trading activity regionally), or if something like a pan-Asian exchange is created, market forces could allow for something like a cross-border tape to emerge, Wheatley says. The creation of, say, a Greater China trading platform would benefit investors enormously, but vested interests in all three markets make this nothing more than a dream.
Mackay says: "You need to encourage competition if you want to achieve best execution. I hope Asian regulators look at this," adding that best execution has made great strides in Europe without undermining domestic brokerage industries.
Wheatley also criticises the industry for being lax, noting trading members of exchanges in Asia have failed to roll out the kind of technological platforms that would allow more sophisticated trading.
The good news is that 2006 and 2007 saw the arrival of hedge funds with aggressive, high-volume trading strategies like statistical arbitrage. This motivated brokers to roll out the first dark pools and algorithms. Although these have been accused of fragmenting already thin pools of liquidity, Wheatley says having more alternatives increases overall trading volumes.